financial institutions exam 2

treasury notes

below 10 years

• backed by the full faith and credit of the U.S. government

• no default risk

treasury bonds

above 10 years

• backed by the full faith and credit of the U.S. government

• no default risk

TIPS

principal amount of bond is indexed to inflation

• adjusted every 6 months based on Consumer Price Index

treasury STRIPS

separate trading of registered interest and principal securities

• helps immunize against interest rate risk

municipal bonds

securities issued by state and local governments

• attractive to household investors because interest is exempt from federal and most local income taxes

general obligation bond

backed by the full faith and credit of issuing municipality 

revenue bonds

sold to finance specific revenue generating projects

formula to compare muni bonds with corporate bonds

interest rate after tax= interest rate before tax (1-tax)

corporate bond yielding 10%, for a 28% tax bracket, what is tax equivalent of muni bond

10%(1-28%)= 7.2%

• muni bond only has to offer a 7.2% yield to be just as appealing as the 10% corporate bond

corporate bond

long-term obligations issued by corporations

convertible bonds

may be exchanged for another security of the issuing firm

convertible bonds vs non-convertible bonds

rate of return on convertible= rate of return on non convertible - value of conversion options

callable bonds

gives the issuer permission to redeem its bond before the stated maturity.

bond credit ratings

• AAA- yield is lower with less risk and investment grade

• BBB- - D- yield is higher with more risk and not investment grade

mutual fund

bought and sold only once per day at the closing net asset value (NAV)

ETF

trades throughout the day on stock exchanges like individual stocks

short term mutual funds

• money market mutual funds

• most popular

• virtually no liquidity or default risk

long term mutual funds

1. equity funds: consist of common and preffered stock securities

2. bond funds: consist of fixed income capital market debt securities

NAV

net asset value

• shows per per-market value of the mutual fund

• total value of assets/number of outstanding shares

turnover

percentage that measures how frequently a fund's assets are bought and sold over a year, indicating its trading activity. A higher turnover ratio suggests a more active trading strategy, while a lower one indicates a buy-and-hold approach

Expense ratio

expressed as a percentage of the total assets, to cover the costs of managing and operating it

• .5% expense ratio on $10,000 would mean $50 annually

holdings

individual stocks and bonds that a mutual fund owns

• determines overall performance

market order

guarantees immediate execution but not a specific price, making it ideal for urgent trades in highly liquid stocks

limit order

guarantees a specific price or better, but it is only executed if the market price reaches your limit, meaning execution isn't guaranteed. 

if Ashley places a limit sell order, and her price is close to ____, her order is more likely to be filled quickly

bid

morning star style box set up

• vertically: large, mid, small

• horizontally: value, core/blend, growth

trailing P/E

current price/ trailing EPS

projected P/E

current price/ projected EPS

dividend yield

dividends per share/ share price

fixed rate mortgage

lock in borrowers interest rate

adjustable rate mortgages

tie borrowers interest rate for the first few years (stated), then adjusts every year after that

interest rate caps

limits how much the interest rate or monthly payment can be changed at the end of each adjustment period over the loan

5/1 ARM

• interest rate stays the same for the first 5 years

• changes for the rest of the mortgage on a yearly basis

Mortgage backed security

investment that pools together many individual mortgages and sells them to investors as a single security

Pass through mortgage securities

“pass through” promised payments of principal and interest on pools of mortgages created by FI’s

three agencies directly involved in created of MBS pass through securities are

1. Ginnie Mae

2. Fannie Mae

3. Freddie Mae

GSE

government-sponsored enterprises

• have backing from the federal government

collateralized mortgage obligation

mortgage backed bonds with multiple bond holder classes, or TRANCHES

Tranche

specific class of bond that pools mortgages and sells them to investors

• each tranche has its own risk and maturity

common stock

includes voting rights and a higher potential for capital appreciation

preffered stock

priority for fixed dividends and claims on assets in the event of bankruptcy

return to a stockholder over a period of time

= (P1-P0/P0)+(Dividend/P0)

capital yield equation

(P1-P0/P0)

dividend yield equation

Dividend/ P0

EPS

indicates how much profit a company generates for each share of its common stock

price to earnings

how much investors are willing to pay for $1 of a company’s earnings

• P/E of 50 means investors paying $50 for every $1 of annual earnings.

price to book

valuation metric that compares a company's market value to its book value. 

• P/B of 2 means that market value of equity is typically higher than a securities book value

price to sales

compares stock price of business to revenue.